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Professional service exclusions in directors and officers liability policies could spur attempts to deny claims for corporate lawyers at companies caught up in the stock options backdating scandal, D&O experts say.
A recent $3 million settlement of civil charges against the former general counsel of a technology company highlights the potential exposure of corporate legal staffs at companies under investigation.
But some D&O insurers may seek to avoid liability for such settlements by arguing that general counsels, who have a dual role as company officers and company lawyers at public companies, are excluded under wordings barring coverage for their work as a corporate legal advisor.
The Securities and Exchange Commission is examining more than 120 companies for improper options practices including backdating, and many of them face shareholder securities and derivative suits stemming from the probes.
At some implicated companies, general counsels are among those named in the suits, "with the claims being that it was often the general counsel who often served as the corporate secretary as well as being the person who signed off on the backdating of the options," said Daniel Winters, a partner at Reed Smith L.L.P. in New York with expertise in D&O insurance litigation.
The SEC is monitoring the role of general counsels, among other executives, in the backdating of option grants because general counsels are among those with the responsibility to protect investors from being defrauded, according to Walter Ricciardi, the SEC's deputy director of enforcement in Washington. "And when they (general counsels) participate in intentional misconduct, it's important that the commission address such misbehavior," he said.
Earlier this month, William F. Sorin, the former general counsel of Comverse Technology Inc. in Wakefield, Mass., became one of the first executives to settle with the SEC over civil fraud charges stemming from the backdating scandal. Mr. Sorin--who agreed to pay more than $3 million in civil penalties, disgorgement and prejudgment interest--in August was charged with creating phony company records to permit the backdating of stock options at Comverse and its Ulticom Inc. subsidiary. A Comverse spokesman would not comment on insurance coverage.
The involvement of general counsels in the backdating of stock options calls attention to a possible deficiency in insurance coverage for corporate general counsels. "I think there is a lot of finger pointing at general counsels and I don't think they're adequately protected," said Brian Rosenbaum, senior legal consultant for the financial services group of Aon Reed Stenhouse Canada in Toronto.
Under traditional D&O policies, general counsels at a public company can typically be indemnified as officers of the company.
"Except for obvious exclusions for intentional misconduct...coverage would be afforded to general counsels," said Michael Price, New York-based vp of Hartford Financial Products, a unit of Hartford Financial Services Group Inc.
Still, some D&O policies have professional service exclusions that could bar coverage if an insurer takes the position that certain tasks performed by the general counsel are outside the scope of an officer's duty, brokers and insurers say.
"As a general matter, under most D&O policies the general counsel is covered as an executive of the company," said Ann Longmore, a New York-based senior vp and the D&O product leader with the executive risk practice at Willis North America, a unit of Willis Group Holdings Ltd. "However, they are not covered for their professional exposures and that's the puzzle we have."
In the event of a claim, an insurer could argue that a general counsel offering legal advice to the board of directors was acting in a capacity of a lawyer, separate from the role of a company officer, experts note.
A "potential argument that someone could make that 'this is a D&O contract and we don't cover you as you are making decisions as a lawyer,"' said Heather Fox, chief underwriting officer and senior vp, National Union Fire Insurance Co. of Pittsburgh, Pa., a New York-based unit of American International Group Inc., who added that the general counsel "in our contract is expressly named."
"This is an argument that has come up repeatedly...it's really an attempt to engage in an improper dodge," said William G. Passanante, a partner at New York policyholder law firm Anderson Kill & Olick P.C.
Whether this argument will be raised by insurers with regard to backdating claims remains to be seen, but as claims volume stemming from options probes increases, insurers will be pressured to take a "hard-line position," Aon's Mr. Rosenbaum said.